Commercial Portfolio Credit Risk Management
Credit risk management for the commercial portfolio begins with an assessment of the credit risk profile of the borrower or counterparty based on an analysis of the financial position of a borrower or counterparty. As part of the overall credit risk assessment of a borrower or counterparty, most of our commercial credit exposure or transactions are assigned a risk rating and are subject to approval based on defined credit approval standards. Subsequent to loan origination, risk ratings are monitored on an ongoing basis. If necessary, risk ratings are adjusted to reflect changes in the financial condition, cash flow or financial situation of a borrower or counterparty. We use risk rating aggregations to measure and evaluate concentrations within portfolios. Risk ratings are a factor in determining the level of assigned economic capital and the allowance for credit losses. In making credit decisions, we consider risk rating, collateral, country, industry and single name concentration limits while also balancing the total borrower or counterparty relationship and SVA. Our lines of business and Risk Management personnel use a variety of tools to continuously monitor the ability of a borrower or counterparty to perform under its obligations.
For information on our accounting policies regarding delinquencies, nonperforming status and charge-offs for the commercial portfolio, see Note 1 of the Consolidated Financial Statements.
Management of Commercial Credit Risk Concentrations
Portfolio credit risk is evaluated and managed with a goal that concentrations of credit exposure do not result in undesirable levels of risk. We review, measure, and manage concentrations of credit exposure by industry, product, geography and customer relationship. Distribution of loans and leases by loan size is an additional measure of the portfolio risk diversification. We also review, measure, and manage commercial real estate loans by geographic location and property type. In addition, within our international portfolio, we evaluate borrowings by region and by country. Tables 18 and 20 and Tables 23 through 25 summarize these concentrations. Additionally, we utilize syndication of exposure to third parties, loan sales and other risk mitigation techniques to manage the size and risk profile of the loan portfolio.
From the perspective of portfolio risk management, customer concentration management is most relevant in Global Corporate and Investment Banking. Within that segment's Business Lending and Capital Markets and Advisory Services businesses, we facilitate bridge financing to fund acquisitions and other short-term needs as well as provide syndicated financing for our clients. These concentrations are managed in part through our established "originate to distribute" strategy. These client transactions are sometimes large and leveraged. They can also have a higher degree of risk as we are providing offers or commitments for various components of the clients' capital structures, including lower rated unsecured and subordinated debt tranches. In many cases, these offers to finance will not be accepted. If accepted, these highly conditioned commitments are often retired prior to or shortly following funding via the placement of securities, syndication or the client's decision to terminate. Where we have a binding commitment and there is a market disruption or other unexpected event, there may be heightened exposure in the portfolios, an increase in criticized assets and higher potential for loss, unless an orderly disposition of the exposure can be made.
In Global Corporate and Investment Banking, concentrations are actively managed through the underwriting and ongoing monitoring processes, the "originate to distribute" strategy and through the utilization of various risk mitigation tools, such as credit derivatives, to economically hedge our risk to certain credit counterparties. Credit derivatives are financial instruments that we purchase for protection against the deterioration of credit quality. Earnings volatility increases due to accounting asymmetry as we mark-to-market the credit derivatives, as required by SFAS 133, whereas the exposures being hedged, including the funding commitments, are accounted for on an accrual basis. Once funded, these exposures are accounted for at historical cost less an allowance for credit losses or, if held-for-sale, at the lower of cost or market.
Commercial Credit Portfolio
Commercial credit quality continued to be stable in 2006. At December 31, 2006, the loans and leases net charge-off ratio declined to 0.13 percent from 0.16 percent at December 31, 2005. The nonperforming loan ratio declined to 0.31 percent from 0.33 percent.
Table 15 presents our commercial loans and leases and related asset quality information for 2006 and 2005.
December 31 | Year Ended December 31 | |||||||||
---|---|---|---|---|---|---|---|---|---|---|
Outstandings | Nonperforming | Accruing Past Due 90 Days or More (1) |
Net Charge- offs (2) |
Net Charge-off Ratios (3) |
||||||
(Dollars in millions) | 2006 | 2005 | 2006 | 2005 | 2006 | 2005 | 2006 | 2005 | 2006 | 2005 |
Commercial loans and leases | ||||||||||
Commercial domestic |
$ |
$ |
$ |
$ |
$ |
$ |
$ |
$ |
0.22 % |
0.13 % |
Commercial real estate (4) | 36,258 | 35,766 | 118 | 49 | 78 | 4 | 3 | | 0.01 | |
Commercial lease financing | 21,864 | 20,705 | 42 | 62 | 26 | 15 | (28) | 231 | (0.14) | 1.13 |
Commercial-foreign | 20,681 | 21,330 | 13 | 34 | 9 | 32 | (8) | (72) | (0.04) | (0.39) |
Total commercial loans
and leases |
$ |
$ |
$ |
$ |
$ |
$ |
$ |
$ |
0.13 % |
0.16 % |
Table 16 presents commercial credit exposure by type for utilized, unfunded and total committed credit exposure.
December 31 | ||||||
---|---|---|---|---|---|---|
Commercial Utilized (1) |
Commercial Unfunded (2) |
Total Commercial Committed |
||||
(Dollars in millions) | 2006 | 2005 | 2006 | 2005 | 2006 | 2005 |
Loans and leases |
$ |
$ |
$ |
$ |
$ |
$ |
Standby letters of credit and financial guarantees | 46,772 | 43,096 | 6,234 | 5,033 | 53,006 | 48,129 |
Derivative assets (3) | 23,439 | 23,712 | | | 23,439 | 23,712 |
Assets held-for-sale | 21,936 | 16,867 | 1,136 | 848 | 23,072 | 17,715 |
Commercial letters of credit | 4,258 | 5,154 | 224 | 818 | 4,482 | 5,972 |
Bankers' acceptances | 1,885 | 1,643 | 1 | 1 | 1,886 | 1,644 |
Securitized assets | 1,292 | 1,914 | | | 1,292 | 1,914 |
Foreclosed properties | 10 | 31 | | | 10 | 31 |
Total |
$ |
$ |
$ |
$ |
$ |
$ |
Table 17 presents commercial utilized criticized exposure by product type and as a percentage of total commercial utilized exposure for each category presented. Bridge exposure of $550 million as of December 31, 2006 and $442 million as of December 31, 2005, are excluded from the table below. These exposures are carried at the lower of cost or market and are managed in part through our "originate to distribute" strategy (see Management of Commercial Credit Risk Concentrations for more information on bridge financing). Had this exposure been included, the ratio of commercial utilized criticized exposure to total commercial utilized exposure would have been 2.25 percent and 2.42 percent as of December 31, 2006 and December 31, 2005, respectively.
December 31, 2006 | December 31, 2005 | |||
---|---|---|---|---|
(Dollars in millions) | Amount | Percent (3) | Amount | Percent (3,4) |
Commercial domestic |
$ |
2.41 % |
$ |
2.59 % |
Commercial real estate | 815 | 1.78 | 723 | 1.63 |
Commercial lease financing | 504 | 2.31 | 611 | 2.95 |
Commercial foreign | 582 | 1.05 | 797 | 1.48 |
Total commercial utilized criticized exposure |
$ |
2.09 % |
$ |
2.28 % |
Commercial Domestic
At December 31, 2006, approximately 80 percent of the commercial domestic portfolio was included in Business Lending (business banking, middle market and large multinational corporate loans and leases) and Capital Markets and Advisory Services (acquisition and bridge financing), both within Global Corporate and Investment Banking. Outstanding loans and leases in Global Corporate and Investment Banking increased $11.6 billion to $130.0 billion at December 31, 2006 compared to December 31, 2005 driven by organic growth. Nonperforming loans and leases declined by $45 million to $460 million driven by overall improvements in the portfolio. Net charge-offs were up $72 million from 2005 due to a lower level of recoveries. Criticized utilized exposure, excluding bridge exposure, remained essentially flat at $4.6 billion.
The remaining 20 percent of the Commercial domestic portfolio is in Global Wealth and Investment Management (business-purpose loans for wealthy individuals) and Global Consumer and Small Business Banking (business card and small business loans). Outstanding loans and leases increased $9.8 billion to $32.0 billion at December 31, 2006 compared to December 31, 2005 driven primarily by growth in Global Consumer and Small Business Banking. Growth was centered in the business card portfolio, including the addition of MBNA, and the small business portfolio. Nonperforming loans and leases increased $48 million to $124 million due to seasoning of the small business portfolio and the addition of MBNA, both within Global Consumer and Small Business Banking. Loans past due 90 days or more and still accruing interest increased $153 million to $215 million primarily attributable to the business card portfolio. The increase was driven by the adoption of MBNA collection practices that have historically led to higher delinquencies but lower losses, the addition of the MBNA business card portfolio and portfolio seasoning. Net charge-offs were up $94 million from 2005 due to a $134 million increase in Global Consumer and Small Business Banking, partially offset by a 2006 credit loss recovery in Global Wealth and Investment Management. The increase in net charge-offs in Global Consumer and Small Business Banking was due to the addition of MBNA and seasoning of the small business and business card portfolios. Criticized utilized exposure increased $265 million to $561 million driven by an increase in the business card portfolio resulting primarily from the addition of MBNA.
Commercial Real Estate
The commercial real estate portfolio is managed in Business Lending within Global Corporate and Investment Banking and consists of loans issued primarily to public and private developers, homebuilders and commercial real estate firms. Outstanding loans and leases increased $492 million in 2006 compared to 2005. The increase was driven by business generated predominantly with existing clients across multiple property types. Utilized criticized exposure increased $92 million to $815 million driven by a $147 million increase in the utilized criticized loan and lease portfolio, attributable to the deterioration of a number of relatively small credits in a variety of property types, the largest of which is residential. The increase was partially offset by improvements centered in hotels/motels and multiple use commercial properties.
Table 18 presents outstanding commercial real estate loans by geographic region and property type diversification, excluding those commercial loans and leases secured by owner-occupied real estate. Commercial loans and leases secured by owner-occupied real estate are made on the general creditworthiness of the borrower where real estate is obtained as additional security and the ultimate repayment of the credit is not dependent on the sale, lease and rental, or refinancing of the real estate. For purposes of this table, commercial real estate reflects loans dependent on the sale of the real estate as the primary source of repayment. The increase in residential property type loans was driven by higher utilizations in the for-sale housing sector due to increased construction and land cost.
December 31 | ||
---|---|---|
(Dollars in millions) | 2006 | 2005 |
By Geographic Region (1) | ||
California |
$ |
$ |
Northeast | 6,368 | 6,337 |
Southeast | 5,097 | 4,370 |
Florida | 3,898 | 4,507 |
Southwest | 3,787 | 3,658 |
Midwest | 2,271 | 2,595 |
Northwest | 2,053 | 2,048 |
Midsouth | 2,006 | 1,485 |
Other | 870 | 873 |
Geographically diversified (2) | 1,549 | 1,693 |
Non-U.S. | 578 | 585 |
Total |
$ |
$ |
By Property Type | ||
Residential |
$ |
$ |
Office buildings | 4,823 | 4,984 |
Apartments | 4,277 | 4,461 |
Land and land development | 3,956 | 3,715 |
Shopping centers/retail | 3,955 | 4,165 |
Industrial/warehouse | 3,247 | 3,031 |
Multiple use | 1,257 | 996 |
Hotels/motels | 1,185 | 790 |
Resorts | 180 | 183 |
Other (3) | 5,227 | 5,840 |
Total |
$ |
$ |
Commercial Lease Financing
The commercial lease financing portfolio is managed in Business Lending within Global Corporate and Investment Banking. Outstanding loans and leases increased $1.2 billion in 2006 compared to 2005 due to organic growth. Net charge-offs decreased $259 million compared to the prior year as 2005 included a higher level of airline industry charge-offs.
Commercial foreign
The Commercial foreign portfolio is managed primarily in Business Lending and Capital Markets and Advisory Services, both within Global Corporate and Investment Banking. Outstanding loans and leases declined by $649 million at December 31, 2006 compared to December 31, 2005 driven by the sale of our Brazilian operations and Asia Commercial Banking business, partially offset by increases due to organic growth, principally in Western Europe. Nonperforming loans and criticized utilized exposure, excluding bridge exposure, decreased $21 million and $215 million, respectively, primarily attributable to the sale of our Brazilian operations. Commercial foreign net charge-offs were in a net recovery position in both 2006 and 2005. The lower net recovery position in 2006 was driven by higher net charge-offs in Brazil as well as lower recoveries in Asia. For additional information on the Commercial foreign portfolio, refer to Foreign Portfolio discussion.
Nonperforming Commercial Assets Activity
Table 19 presents the additions and reductions to nonperforming assets in the commercial portfolio during 2006 and 2005.
(Dollars in millions) | 2006 | 2005 |
---|---|---|
Nonperforming loans and leases | ||
Balance, January 1 |
$ |
$ |
Additions to nonperforming loans and leases: | ||
New nonaccrual loans and leases | 980 | 892 |
Advances | 32 | 37 |
Reductions in nonperforming loans and leases: | ||
Paydowns and payoffs | (403) | (686) |
Sales | (152) | (108) |
Returns to performing status (2) | (80) | (152) |
Charge-offs (3) | (331) | (669) |
Transfers to foreclosed properties | (3) | (19) |
Transfers to loans held-for-sale | (12) | (44) |
Total net additions to (reductions in) nonperforming loans and leases | 31 | (749) |
Total nonperforming loans and leases, December 31 (4) | 757 | 726 |
Foreclosed properties | ||
Balance, January 1 | 31 | 33 |
Additions to foreclosed properties: | ||
New foreclosed properties | 6 | 32 |
Reductions in foreclosed properties: | ||
Sales | (18) | (24) |
Writedowns | (9) | (8) |
Charge-offs | | (2) |
Total net reductions in foreclosed properties | (21) | (2) |
Total foreclosed properties, December 31 | 10 | 31 |
Nonperforming commercial assets, December 31 (5) |
$ |
$ |
Nonperforming commercial loans and leases as a percentage of outstanding commercial loans and leases |
0.31 % |
0.33 % |
Nonperforming commercial assets as a percentage of outstanding commercial loans, leases and foreclosed properties |
0.32 % |
0.35 % |
Industry Concentrations
Table 20 presents commercial committed credit exposure and the net credit default protection portfolio by industry. Our commercial credit exposure is diversified across a broad range of industries. Total commercial credit exposure increased by $53.8 billion, or 10 percent, in 2006 compared to 2005. Banks increased by $5.9 billion, or 19 percent due to increased activity in Capital Markets and Advisory Services within Global Corporate and Investment Banking, primarily in Australia and the United Kingdom. Government and public education increased $5.9 billion, or 18 percent, due primarily to growth concentrated in U.S. state and local entities, including both government and public education, consistent with our growth strategy for this sector. Healthcare equipment and services, and media increased $5.6 billion, or 22 percent, and $3.8 billion, or 25 percent, respectively, of which $2.3 billion and $2.5 billion was attributable to bridge and/or syndicated loan commitments, most of which are expected to be distributed in the normal course of executing our "originate to distribute" strategy. MBNA also contributed to growth in a number of industries, including healthcare equipment and services, and individuals and trusts.
Credit protection is purchased to cover the funded portion as well as the unfunded portion of certain credit exposure. To lessen the cost of obtaining our desired credit protection levels, credit exposure may be added within an industry, borrower or counterparty group by selling protection. Since December 31, 2005, our net credit default protection purchased has been reduced by $6.4 billion reflecting our view of the underlying risk in our credit portfolio and our near term outlook on the credit environment.
At December 31, 2006 and 2005, we had net notional credit default protection purchased in our credit derivatives portfolio of $8.3 billion and $14.7 billion. The net cost of credit default protection, including mark-to-market impacts, resulted in net losses of $241 million in 2006 compared to net gains of $49 million in 2005. Losses in 2006 primarily reflected the impact of credit spreads tightening across most of our hedge positions. The average Value-at-Risk (VAR) for these credit derivative hedges was $54 million and $69 million for the twelve months ended December 31, 2006 and 2005. The decrease in VAR was driven by a decrease in the average amount of credit protection outstanding during the period. There is a diversification effect between the credit derivative hedges and the market-based trading portfolio such that their combined average VAR was $57 million and $62 million for the twelve months ended December 31, 2006 and 2005. Refer to the Trading Risk Management discussion for a description of our VAR calculation for the market-based trading portfolio.
December 31 | ||||||
---|---|---|---|---|---|---|
Commercial Utilized | Total Commercial Committed | Net Credit Default Protection (2) |
||||
(Dollars in millions) | 2006 | 2005 | 2006 | 2005 | 2006 | 2005 |
Real estate (3) |
$ |
$ |
$ |
$ |
$ |
$ |
Diversified financials | 24,802 | 24,975 | 67,027 | 64,073 | (121) | (250) |
Retailing | 27,226 | 25,189 | 44,064 | 41,967 | (581) | (1,134) |
Government and public education | 22,495 | 19,041 | 39,254 | 33,350 | (25) | |
Capital goods | 16,804 | 15,337 | 37,337 | 33,004 | (402) | (741) |
Banks | 26,405 | 21,755 | 36,735 | 30,811 | (409) | (315) |
Consumer services | 19,108 | 17,481 | 32,651 | 29,495 | (433) | (788) |
Healthcare equipment and services | 15,787 | 13,455 | 31,095 | 25,494 | (249) | (709) |
Individuals and trusts | 18,792 | 16,754 | 29,167 | 24,348 | 3 | (30) |
Materials | 15,882 | 16,754 | 28,693 | 28,893 | (630) | (1,119) |
Commercial services and supplies | 15,204 | 13,038 | 23,512 | 21,152 | (372) | (472) |
Food, beverage and tobacco | 11,341 | 11,194 | 21,081 | 20,590 | (319) | (580) |
Media | 8,659 | 6,701 | 19,056 | 15,250 | (871) | (1,790) |
Energy | 9,350 | 9,061 | 18,405 | 17,099 | (236) | (589) |
Utilities | 4,951 | 5,507 | 17,221 | 15,182 | (362) | (899) |
Transportation | 11,451 | 11,297 | 17,189 | 16,980 | (219) | (323) |
Insurance | 6,573 | 4,745 | 14,121 | 13,868 | (446) | (1,493) |
Religious and social organizations | 7,840 | 7,426 | 10,507 | 10,022 | | |
Consumer durables and apparel | 4,820 | 5,142 | 9,117 | 9,318 | (170) | (475) |
Technology hardware and equipment | 3,279 | 3,116 | 8,046 | 7,171 | (38) | (402) |
Telecommunication services | 3,513 | 3,520 | 7,929 | 9,193 | (1,104) | (1,205) |
Pharmaceuticals and biotechnology | 2,530 | 1,675 | 6,289 | 4,906 | (181) | (470) |
Software and services | 2,757 | 2,573 | 6,206 | 5,708 | (126) | (299) |
Automobiles and components | 1,529 | 1,602 | 5,098 | 5,878 | (483) | (679) |
Food and staples retailing | 2,153 | 2,258 | 4,222 | 4,241 | (116) | (324) |
Household and personal products | 720 | 536 | 2,205 | 1,669 | 50 | 75 |
Semiconductors and semiconductor equipment |
802 | 536 | 1,364 | 1,119 | (18) | (54) |
Other | 6,396 | 2,503 | 6,825 | 2,926 | 302 (4) | 1,677 (4) |
Total |
$ |
$ |
$ |
$ |
$ |
$ |
Tables 21 and 22 present the maturity profiles and the credit exposure debt ratings of the net credit default protection portfolio at December 31, 2006 and 2005.
December 31 | ||
---|---|---|
2006 | 2005 | |
Less than or equal to one year |
7 % |
% |
Greater than one year and less than or equal to five years | 46 | 65 |
Greater than five years | 47 | 35 |
Total |
100 % |
100 % |
(Dollars in millions) | December 31, 2006 | December 31, 2005 | ||
---|---|---|---|---|
Ratings | Net Notional |
Percent | Net Notional |
Percent |
AAA |
$ |
0.3 % |
$ |
0.2 % |
AA | (237) | 2.9 | (523) | 3.6 |
A | (2,598) | 31.5 | (4,861) | 33.1 |
BBB | (3,968) | 48.0 | (8,572) | 58.2 |
BB | (1,341) | 16.2 | (1,792) | 12.2 |
B | (334) | 4.0 | (424) | 2.9 |
CCC and below | (50) | 0.6 | (149) | 1.0 |
NR (2) | 291 | (3.5) | 1,650 | (11.2) |
Total |
$ |
100 % |
$ |
100 % |